Soros and Volcker on Financial Innovation

I had a business trip late last week, so I used the plane flight home to read The Sages, by Charles Morris. It includes three short sketches of Warren Buffett, George Soros, and Paul Volcker, wrapped around the thesis that the recent financial crisis showed the importance of pragmatism and experience rather than sophisticated financial models. Obviously I’m just grabbing a couple of passages here that I found interesting.

Here’s Soros (pp. 42-43):

“I am a man of the markets, and I abhor bureaucratic restrictions. I try to find my way around them. … But I do believe that financial markets are inherently unstable; I also recognize that regulations are inherently flawed: Therefore stability ultimately depends on a cat-and-mouse game between markets and regulators. Given the ineptitude of regulators, there is some merit in narrowing the scope and slowing down the rate of financial innovations.”

And here’s Volcker (p. 160), as paraphrased by Morris:

“He scoffed at the notion that clamping down on banks, hedge funds, and other players would stifle ‘innovation.’ The only innovation that real people cared about for the previous twenty or thirty years, he said, was ‘the automatic teller machine.'”

By James Kwak

24 thoughts on “Soros and Volcker on Financial Innovation

  1. And as I remember there was a lot of debate over whether ATM’s were just substituting for good service and the cost of running a lot of branches. As I remember Chase who then had a bunch of NY offices ran a campaign about how your weren’t just a number. Ah, good times.

  2. Rob Johnson took up the chimera of innovation at NewDeal2.0 ( last month, and it stuck with me. It seems like one of the key lessons of this crisis isn’t in the nitty gritty details, though I’m sure we’re getting screwed with those too, but in the idea that we have to question the big-picture vision, especially when its cogs try to tell us not to.

  3. we at the cubicle level who still had a knowledge of how stuff looked like before it became presented in data banks were regularly shocked at how people believed any obvious nonsense couldn’t be nonsense if the computer seemed to say to them it was a truth. They seemed even to forget that they had once learned that 2 times 2 is four. The look at the screen made them forget anything they had once known about context or probability.

  4. Soros is one of my favorite fat cats because he generally tells the truth. But his analysis of markets leads inescapably to the conclusion that we should return them to 1954 as soon as possible. The thing is, all that money (infinite money, essentially) can do nothing else but jump from one asset class to another. There is only so much beach front property in the Hamptons. What ‘financial innovation’ boils down to is that the cheaper money becomes for fat cats and the Treasury, the more expensive it becomes for those who can only live by selling their labor. That used to be called usury and there were laws against it.

  5. It finally hit me that attempts at “controlling” financial innovations only puts a crimp on the smaller, slower financial institutions. The big investment houses are built to take regulatory matters in stride, and welcome new regulations (as opposed to mandated restructuring) as a useful way of handicapping less-equipped competition.

  6. If all what our financial regulators worry about is the financial sector not defaulting it is clear that sooner or later we are all going to end up as economic viable alternatives to ATMs, perhaps working in them as a hidden operators.

  7. And also for the smaller entrepreneurs who finds it much more difficult to hustle up an AAA

    Have you ever seen an AAA given to a small corner shop even though we all know he is more AAA than an AIG?

  8. The only way that small corner shop can gain access to an AAA is through securitization but in doing so he must give up his name and be canned like a sardine with other small corner shops and cut into tranches and sold off to unknown creditors he will never ever be able to look into their eyes, in fact he will not even know the color of their eyes.

  9. Volker, if quoted correctly, is just being silly. What about sweep accounts, online banking and P-P payments, mobile payments, rewards on cards, planning tools, etc., etc.? I agree entirely that way too much innovation has been directed at building a fat cat industry without benefiting–indeed actually often fleecing customers–but extreme rhetoric just undermines the ability to have a decent conversation about proper public policy.
    I do agree with Volker that you cannot just clamp down on “innovation,” good and bad. We have to have a combination of structural and functional constraints and, of course, an attitude adjustment within the culture of the industry. None of it is an easy fix.

  10. Lawrence Baxter “but extreme rhetoric just undermines the ability to have a decent conversation about proper public policy”

    Well said. On the dot.

  11. Doesn’t it strike any of you that Soros, who has backed with billions, politicians who want to heavily regulate nearly every facet of our daily lives, would prefer no regulation for himself?

    What is good for thee, is not for me!

    Oh and the $2 billion given to Soros’ oil company, Petrobas to drill in Brazil by Obama was just a payback for Soros being such a free market kind of guy. Hypocrite!

    It seems a certain amount of regulation in the market is necessary to keep the market honest and free. Soros, accused by many of illegal trading and fraud, of course doesn’t want to be regulated at all. The crooked Casino is fine by him, as long as he is in on the take.

    On the other hand, Volker it seems, has never seen a financial regulation he didn’t like. Marketplace innovations apparently have never created value in Volker’s world. Increased productivity and wealth creation apparently is of no use to him.

    That has to be a better way.

    The correct approach to market regulation is a difficult subject, but it would seem to me an approach that respects our Constitutional rights, works to eliminate fraud and abuse and attempts to create honesty, openness and transparency would be a good start.

  12. Again I am just a foreigner and so I feel a bit uncomfortable about it but, nonetheless, as the future wellbeing of my family will undoubtedly depend a lot on the wellbeing on the US…when I read a sensible position like the one expressed by Paul, saying “The correct approach to market regulation is a difficult subject, but it would seem to me an approach that respects our Constitutional rights, works to eliminate fraud and abuse and attempts to create honesty, openness and transparency would be a good start”… I do feel like saying… “And for that, ask all your progressive and conservatives pundits to Shut Up! and get down working at it. I am sure you still have it in you… at least for some years more.”

  13. If these people want to create “financial innovation” fine. Don’t allow them to do it with leverage from small depositors’ savings and checking accounts. Let them create, buy and sell these derivatives with their own cash and equity. If these derivatives are so great, let greasy parasites like Phil Gramm of Texas invest the money they made from lobbying for banks in it.

  14. Yes, Paul Volkker is right about the ATM. Financial innovation has paved the road to ruin for the world economy. Without effective regulation (i.e. approval of any financial product before its usage), we cannot have a safe financial marketplace. The major problem that I see is that those in the erudite financial community seem to feel that the economy’s financial markets are theirs and theirs alone, and that the rest of us should just leave them alone. We have recently learned valuable lessons about those who believe that they effectively operate in vacuums.

    Our world is so highly interconnected that his kind of view has proven to be completely and utterly unsupportable.

  15. To me it looks like you make an apple and orange comparition (which by the way very often is meaningful). You are comparing the benefits of changes in how we communicate the transactions, with changes in the substance of the transactions. I may call my broker and ask him to do an investment, or I may use the internet to do the same. No big difference. I may order him to move money from my checking account to my savings account, or to buy a CDO for the same money. Big difference.

  16. Keep in mind that delivery channels are themselves value add (for the consumer as well as the institution), and so are things like different ways to move money. I would also regard these as innovations, or innovative applications that have benefited customers every bit as much as the ATM. I think the key issue is whether innovation benefits the consumer or is merely a device to extract more fees, thereby only benefiting the “innovator.” If I understand them correctly, this is the point Simon Johnson and James Kwak were trying to make, and why I thought that Paul Volcker (as quoted) was being over-simplistic and funny, but unhelpful.

  17. You’re right. And many of them, I imagine, happen to (or choose to) ignore perhaps the most erudite of all laissez-fare financial economists, “Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity — myself especially — are in a state of shocked disbelief…I have found a flaw [in my ideology].” (Alan Greenspan, 2008)

    And with respect to the still remaining members of the financial community who cling to the notion that they’re their own best regulators, I defer to the words of Upton Sinclair:
    “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”

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